Financial Reporting Concerns, Framing Effects and Employee Stock Option Grants

54 Pages Posted: 15 Sep 2006

See all articles by James Jianxin Gong

James Jianxin Gong

California State University at Fullerton

Date Written: September 15, 2006

Abstract

Managers are concerned about reported earnings (e.g., Graham et al. 2005). The favorable accounting treatment for employee stock options (ESO) available under the pre-expensing regime lead managers to frame ESOs as cheap to grant (e.g., Murphy 2002 2003; Hall and Murphy 2003; Jensen and Murphy 2004). This paper tests two effects of framing in the context of employee stock option grants: the reference-point-dependent preferences and the ratio-difference principle. I analyze stock option grants to CEOs, the other top 4 executives, and non-executive employees in 859 firms from 1996 to 2002. I find that firms grant more stock options when doing so helps them to meet or beat earnings targets, consistent with the notion of reference-point-dependent preferences in prospect theory. Further, I analyze the relationship between the extent of potential "expense saving" and stock option grants. I find that firms grant more options when granting stock options have a bigger impact on reported earnings, consistent with the ratio-difference principle in mental accounting theory. In sum, results suggest that management decision making of ESO grant is subject to framing effects.

Keywords: financial reporting concerns, framing effects, prospect theory, mental accounting, ratio-difference principle, employee stock options, executive compensation, FAS 123R

Suggested Citation

Gong, Jianxin, Financial Reporting Concerns, Framing Effects and Employee Stock Option Grants (September 15, 2006). AAA 2007 Financial Accounting & Reporting Section (FARS) Meeting Papers. Available at SSRN: https://ssrn.com/abstract=930813 or http://dx.doi.org/10.2139/ssrn.930813

Jianxin Gong (Contact Author)

California State University at Fullerton ( email )

Department of Accounting
Mihaylo College of Business and Economics
Fullerton, CA 92831
United States
(657)278-3897 (Phone)
(657)278-4518 (Fax)

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